Steve Kates gets it badly wrong on Roosevelt, the Great Depression and government spending

It looks like Steve Kates will never get it right on the Great Depression. Harold L. Cole and Lee E. Ohanian wrote a paper blaming Roosevelt’s economic policies for keeping America in depression. Any genuinely informed and honest person would have to agree with them, at least in principle. Now Kates quoted from an articleon the work of these two economists that ended with the following quote from Cole:

The fact that the Depression dragged on for years convinced generations of economists and policy-makers that capitalism could not be trusted to recover from depressions and that significant government intervention was required to achieve good outcomes… Ironically, our work shows that the recovery would have been very rapid had the government not intervened.

Steve Kates took immediate umbrage with this view, asserting that “what it doesn’t do is put the blame on public spending which is where the blame truly belongs.” Now there is a fundamental error in Ohanian and Cole’s work but it has nothing to do with public spending, an issue about which Steve Kates is utterly wrong. We get the same nonsense from Sinclair Davidson and Julie Novak who argue that Australia’s recovery from the Great Depression was due to cuts in public spending plus interest rate reductions and devaluation.

Whether he realises it or not Kates is implying that there is either an inverse correlation between the employment rate, industrial production and government spending or no correlation at all. He is evidently unaware that the statistical evidence for America refutes him. Chart 1 shows that as soon as Roosevelt accelerated spending unemployment began to rapidly fall and industrial production began to steadily expand. A Keynesian would need no further evidence in support of his belief that Roosevelt’s big spending program worked. To him, a correlation of 0.879 between the demand for labour and government spending clinches the matter. The poor showing under Hoover can simply be explained away as proof that he did not spend enough. Looked at from this angle Steve Kates’ argument falls to the ground.

The problem is that Kates provides neither a theory nor facts but mere assertions. Davidson and Novak provide some facts but no theory. To merely point out, as they did, that Australia’s unemployment during the Great Depression began to fall when the government started to cut spending is not proof that one is a function of the other. The same holds for American unemployment rates and increased spending. In the case of Sinclair Davidson and Julie Novak a post-Keynesian could argue that the cuts were in fact deflationary and therefore retarded recovery.

What is completely missing from the Kates-Davidson-Novak argument is any reference to real wage rates and prices. Most Keynesians are no better, prattling on as they do about “demand deficiency”. Economics tells us that in a free market there is a tendency for every factor to be paid the full value (discounted value in the Austrian school of economics) of its marginal product. From this we should conclude that the emergence of persistent widespread unemployment is due to wage rates (total cost of labour to the employer) exceeding the value of the worker’s marginal product.

If this holds then a chart would show an extremely strong inverse correlation between wages rates and the value of the workers’ product. Unfortunately, this is not as easy as it probably sounds. Others have tried to solve the problem by using the price level to measure changes in the real wage during the depression and then compare them with changes in the demand for labour. Perhaps a far better method would be one that ignored the price level by taking the ratio of the money wage rate to the money value of the product. Fortunately, the comprehensive statistics for manufacturing allow us to do just that.

If the theory is correct then this ratio would reveal a strong inverse correlation between money wage rates and the value of manufacturing output, producing what we might call the real factory wage. And that is exactly what Chart 2 does, giving us an extremely strong correlation of 0.8291 for the US. As we can see, the correlation covers the whole period. Chart 3 shows exactly the same thing for Australia where we get an inverse correlation of 0.976, which is virtually perfect2.

These correlations confirm precisely what economic teaching predicts in these circumstances. Steve Kates’ assertions that Roosevelt’s increased spending prolonged the Great Depression are dangerous claptrap. It evidently did not strike Kates, any more than it struck Davidson or Novak, that it does not matter for unemployment how much you devalue, cut spending or interest rates if wage rates are kept above the value of the worker’s product. Unfortunately, now that Kates and Davidson have decided that Roosevelt’s spending binge explains the high level of unemployment that plagued the US economy in the 1930s no other view will be considered by our establishment right. And these are the same people who have got the gall to accuse leftists and Keynesians of being close-minded.

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1The amount of unemployment in US manufacturing would have been higher had it not been for reduced working hours. Working hours in Australian manufacturing never fell below 44 hours during the whole of the depression.

2In the 1920s Professor Frederic Benham used a similar approach in his study of wages and unemployment in Queensland. The correlation was so strong that he stated: “It would be hard to find a clearer proof of our thesis [that excessive wage rates cause unemployment]”. The Prosperity of Australia, P. S. King & Son, LTD, Orchard House, Westminster, 1928, p.p. 210-12. For some peculiar reason our right refuses to refer to Benham’s work.

Once again I leant something new. What amazes me is that Steve kates didnt even know the unemployment and spending figures for America. Its like Sarah said. They make a statement and you are supposed to believe it.

I used to think highly of Kates and the others at Catallaxy but Gerry’s posts made me change my mind. It is just incredible that Kates did not even bother to compare the unemployment rate with Roosevelt’s spending. He just made himself look like a fool.

Nick’s spot on. Steve Kates approach is pathetic. Compare it to how Gerry does it. that chart on the factory wage and unemployment is a knock out. It covers the full period and leaves the keynesian chart on spending and jobs in dust.

On second thoughts this post is better than I realised. That real factory wage concept explains why unemployment fell in Australia even when spending was cut. The method works perfectly for both countries.

I love these articles on the Great Depression even though I usually disagree with them. please keep them up!!

A small thing. some people may think wrongly that Keynes advocated real wage increases. In fact he wanted the opposite ( wage illusion where inflation was greater than the nominal wage increase)and wrote to Roosevelt to that effect.
IMHO if Roosevelt had done that ( increasing real wages was probably a bipartisan policy then) then the US like Germany would have achieved full employment by 1936.

Rightthinker should try reading before he criticises. Gerry said in other articles that Austrians are not against the use of statistics. They believe that theory is there to explain them and not the other way round.

That Keynes wanted to use inflation to cut real wages is a fact I have been pointing out for years, Nottrampis. There was nothing original in his proposal. The classical economists were fully aware of the effects of inflation on the demand for labour. For instance, Henry Thornton noted that inflation increased the demand for labour by lowering the cost of labour. He also drew attention to the consequences of sticky wages during a deflation. Colonel Torrens did likewise. They also understood to a far better degree than today’s economists what brought about the booms and busts. And it isn’t what Steve Kates is telling people.

Further, calling for wage cuts to increase the demand for labour is inconsistent with the opinion that ‘demand deficiency’ causes unemployment, particularly if one focuses on consumption as the driving force behind the economy.

I’m glad you find my stuff interesting. I shall be producing more stuff on the Great Depression as well as other lesser known but important depressions.

Sorry mate, i wasn’t trying to say Keynes came up with the idea but merely he also championed it.

if you increase demand via Government spending ( preferably by boosting infrastructure ) and also reduce real wages then you will get to full employment quite quickly as Germany did.
if you only reduce real wages and rely on a large devaluation then you will get an anaemic recovery as Australia experienced and therefore never get near full employment. Showing Keynes was right and Hawtrey was wrong.

Nottrlampis, I’ve decided to use a post to tackle the points you just raised. That way I can make it longer and readers won’t miss it, which most of them would if I responded now. However, this will be after the next couple of posts. I think you will find tomorrow’s post interesting.